I am going to be making some overseas investments denominated in foreign currencies and am wondering if anyone has experience with using hedging instruments to reduce returns volatility related to currency shifts. I have a call with my prime broker next week to learn more about the mechanics of this but am hoping to have some (relatively) intelligent questions lined up beforehand and would appreciate feedback about what sort of strategies are “typically” used for this kind of hedging. Specific situation: Would like to hedge currency exposure related to investments to foreign equities with an expected holding period of 3-5 years. I am thinking something like a rolling 1 month currency swap hedge that corresponds to the amount of USD made in the initial investment, but am not sure what the best solution would be as there is some question about how well this would hedge positions that appreciate in value over the given time period (i.e., if you hedge a $1 investment, and the investment appreciates to $3 over a 3 year period, but the currency goes against you during that time, you are not really hedge). I am a complete noob at currency hedging (despite passing the CFA exams), so any advice would be appreciated.
Just to clarify, the goal is to maximize the hedge to isolate any underlying alpha of the equities at minimal transaction costs. I am open to any strategy that can accomplish that.
The most direct way to hedge FX risk is to use forward contracts, and then roll the position as time goes on. What do you mean by isolating the “alpha”? Are you also going to short some kind of equity, or do you just mean you want to get the equity return while hedging most of the currency risk?
ohai Wrote: ------------------------------------------------------- > The most direct way to hedge FX risk is to use > forward contracts, and then roll the position as > time goes on. What do you mean by isolating the > “alpha”? Are you also going to short some kind of > equity, or do you just mean you want to get the > equity return while hedging most of the currency > risk? The latter. To the extent possible, I want the total return to be a function of only the equity return (as distinct from any positive or negative currency return), while accounting for hedging fees of course. In other words, I want the return to be as close as possible to a return that would be derived from a USD demoninated asset. Edit: Thanks, I will look into forwards.
forwards would be the easiest hedge w/o knowing exactly what you are doing.